Is Luxxu Group (HKG:1327) Using Debt In A Risky Way?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Luxxu Group Limited (HKG:1327) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Luxxu Group

What Is Luxxu Group's Net Debt?

As you can see below, at the end of December 2020, Luxxu Group had CN¥15.4m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has CN¥83.1m in cash, leading to a CN¥67.7m net cash position.

How Strong Is Luxxu Group's Balance Sheet?

According to the last reported balance sheet, Luxxu Group had liabilities of CN¥1.83m due within 12 months, and liabilities of CN¥15.4m due beyond 12 months. On the other hand, it had cash of CN¥83.1m and CN¥46.3m worth of receivables due within a year. So it actually has CN¥112.1m more liquid assets than total liabilities.

This surplus liquidity suggests that Luxxu Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Luxxu Group boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is Luxxu Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Luxxu Group made a loss at the EBIT level, and saw its revenue drop to CN¥63m, which is a fall of 31%. That makes us nervous, to say the least.

So How Risky Is Luxxu Group?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Luxxu Group lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CN¥16m and booked a CN¥146m accounting loss. But the saving grace is the CN¥67.7m on the balance sheet. That kitty means the company can keep spending for growth for at least two years, at current rates. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Luxxu Group (2 shouldn't be ignored) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

When trading Luxxu Group or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.